The Worth of a Warrant

Transferable subscription rights (TSRs) or warrants (as they are now more commonly called) give the holders the right but not the obligation, to subscribe for new ordinary shares at a pre-determined exercise price within a stipulated validity time frame (exercise period). The warrants become worthless after the expiry of the exercise period. Warrants are thus a form of call options.

When you buy a warrant, you pay the price of the warrant which is usually lower than that of the stock or commodity it covers and so requires less capital than buying the instrument directly. The warrant then gives you the right to purchase the underlying instrument at an agreed price during the exercise period.

For example, when you buy a warrant for a share of a company, you pay the price of the warrant (say, RM0.50 per unit), which is usually much lower than the price of the share. The warrant gives you the right, during the exercise period, to subscribe to the share at a fixed price of, say, RM2 each share. If the prevailing price of the share rises to more than RM2, you might decide to exercise your right and buy the share at the agreed price of RM2.

Should the situation be reversed, whereby the price of the underlying instrument or share as in the example above, falls below RM2, you might decide not to exercise your rights to subscribe to the share at RM2. It is no longer attractive as you can buy it from the market at a lower price. (Please note that the above is just an example to illustrate the point and should not be taken as investment advice to buy or sell warrants).

Remember that the warrant becomes worthless after the exercise period has expired.

Why do companies issue warrants? Warrants are often issued to investors together with debt securities (particularly bonds) in a package. The warrants are detached from the bonds and traded separately. Companies embarking on projects with long gestation periods normally opt to issue such packages. Doing so enables them to raise capital initially from the sale of debt (bonds), and subsequently from the sale of the warrants near the expiry date. The latter is timed to coincide with the time when the potential earnings of the project start materialising so that additional shares issued for the warrants would be supported by higher earnings.